Why Should I Invest?

Welcome to Investing Basics! If you've found your way here, chances are you've either got some money socked away or you're planning to do so. But first things first. Why is investing a smart idea?

Simply put, you want to invest in order to create wealth. It's relatively painless, and the rewards are plentiful. By investing in the stock market, you'll have a lot more money for things like retirement, education, recreation -- or you could pass on your riches to the next generation so that you become your family's Most Cherished Ancestor. Whether you're starting from scratch or have a few thousand dollars saved, Investing Basics will help get you going on the road to financial (and Foolish!) well-being.

Know your goalsWhat are you saving for? Retirement? College for the kids? A new speaker system complete with woofers and tweeters? An exotic animal menagerie complete with Chihuahuas (woofers) and canaries (tweeters)? A retirement villa in the sun-baked hills of Tuscany?

Say you take $2,000 of your savings and put it into the stock market. If your money returned 10% a year (the S&P 500's historical average), two grand would be worth $34,898.80 after 30 years. That might not get you the perfect retirement home, but it'll at least give you a down payment.

Maybe you don't have $2,000 burning a hole in your bank account, but perhaps you can afford to invest your lunch money. Brown-bag your lunch and sock away just $4 a day, 250 days a year. It's not a lot, but if you're in your early 20s, you've got the investor's best ally on your side -- time. If you invest $1,000 once a year in an investment that averages a 10% annual return -- the average annual stock market return since 1926 -- it'll grow to more than $1 million after 46 years, which is right around the time you'll be ready to retire.

Of course, as you get older and more financially stable, you should be able to put away more to invest. Upping the ante to just $166 a month -- which is probably less than lunch money plus what you pay for cable TV -- would put you at the million-dollar mark in just 39 years.

The power of compoundingThe table below shows you how a single investment of $100 will grow at various rates of return. Five percent is about what you might get from a certificate of deposit (CD) or with a government bond over time, 10% is about the historical average stock market return, and 15% is what you might get if you decide to learn how to pick your own stocks and take advantage of some of our lessons in advanced investing techniques.

Growing At

Year

5%

10%

15%

20%

1

$100

$100

$100

$100

5

$128

$161

$201

$249

10

$163

$259

$405

$619

15

$208

$418

$814

$1,541

25

$339

$1,083

$3,292

$9,540

Why is the difference between a few percentage points of return so massive after long periods of time? You are witnessing the miracle of compounding. When your investment gains (returns) begin to earn money, and then those returns start to earn money, your investment can mushroom very quickly. Extend the time period or raise the rate of return, and your results increase exponentially. For instance, if you start young, say at 15 years of age, note how quickly a single $100 investment grows, especially in the later years.

Growing At

Age

5%

10%

15%

20%

15

$100

$100

$100

$100

20

$128

$161

$201

$249

25

$163

$259

$405

$619

30

$208

$418

$814

$1,541

40

$339

$1,083

$3,292

$9,540

50

$552

$2,810

$13,318

$59,067

60

$899

$7,298

$53,877

$365,726

65

$1,147

$11,739

$108,366

$910,044

Looking at it another way, let's compare two teenagers and their lifetime savings habits. Bianca baby-sits a lot and spends most of her spare time reading. She saves $1,000 a year starting when she's 15 and invests it in the stock market for 10 years earning 12% per year on average. After 10 years, she comes out of her shell, stops adding money to her nest egg, and spends every penny she earns club hopping and on trips to Cancun. But she keeps her nest egg in the market.

Compare her account to that of her friend Patrice, who squandered her early paychecks on youthful indiscretions. At age 40 Patrice gets a wake-up call when her parents retire on nothing but Social Security. She starts vigorously socking away $10,000 every year for the next 25 years. Guess who has more at age 65? That's right, Bianca. (You figured it was a setup, didn't you?) Her 10 years of saving $1,000 per year (just $10,000 total -- the same amount Patrice put away in just one year) netted her $1.8 million by age 65. Patrice, on the other hand, scrimped for 25 years to invest a quarter million dollars out of her own pocket and ended up with just under $1.5 million. Neither will be going to the poorhouse, but you see our point: Bianca's baby-sitting money grew for 50 years, twice as long as Patrice's, and Bianca barely missed it.

(It's almost not fair to mention this, but if Bianca put her money in a Roth IRA, that whole $1.8 million would be tax-free. On the other hand, Patrice couldn't put her full $10,000 in a Roth, so Patrice will pay capital gains tax on a good deal of her gains.)

The power of compounding is the single most important reason for you to start investing right now. Every day you are invested is a day that your money is working for you, helping to ensure a financially secure and stable future.

Common pitfalls to avoidBefore you race off through the rest of Investing Basics, there are some cautionary points to consider before you proceed. These are common mistakes many people make when considering what to do about investing.

Doing nothing. There is no guarantee that the market will go up the first day, month, or even year that you invest in it. But there is one guarantee: Doing nothing at all will not provide for a comfortable retirement.

Starting late. Postponing your investing career is second only to not investing at all on the list of investment sins. You already know that the earlier you start the better off you are. (Take another look at the compound return example we gave above.) If you're already past those formative twenties (you don't look a day over 32 to us), we'll reword this first pitfall to read: "Not starting now."

Investing before paying down credit card debt. If you have money in your savings account and you have revolving debt on your credit card, pay it off. Many credit cards have an annual interest rate of 15% or more. Let's say you have $5,000 to invest, but you also have $5,000 debt on your credit cards with an average annual interest rate of 18%. It doesn't take an astrophysicist to figure out that you're going to have to get an 18% return after you pay taxes just to break even on that $5,000. Pay the debt off first, then think about investing.

Investing for the short term. Only invest money for the short term that you're actually going to need in the short term. Invest money in the stock market that you won't need for at least three years, and preferably five years or longer. If you'll need your cash next year for a down payment on a house or for the family Caribbean cruise, use one of the shorter term and safer havens for your cash, such as money market funds or CDs.

Turning down free money. You'd never turn down a dollar if it was offered with no strings attached. That's what you're doing if your company offers a 401(k) or similar retirement savings plan with an employer match and you're not participating. Take advantage of all tax-advantaged, employer-matched savings programs.

Playing it safe. If you're young, most of your investing dollars should be in the stock market. You have enough time to weather any dips in the market and to reap the rewards of long-term gains. Although you may want to transition into bonds later in life as you depend on your investments for income, stocks should make up a large portion of the portfolio of every investor.

Playing it scary. Not every investment is for everyone. Even if you're a daredevil, you shouldn't pour all of your money into something that could end up going down the drain.

Viewing collectibles or lottery tickets as investments. If old comic books, Barbie dolls, and abandoned exercise equipment could be used to fund retirements, do you think the stock market would exist? Probably not. Don't make the mistake of thinking your jewelry, those Beanie Babies, or the lottery will provide for you in your latter years.

Trading in and out of the market. We believe the best approach to investing is the long-term one. Pick your investments well and you'll reap greater rewards over the long term than you had ever dreamed possible. Trade in and out of the market and you'll be saddled with fees that chip away at your returns, and you'll potentially miss out on gains that long-term investors enjoy with much less effort.

Congratulations! You've made it through the first part of Investing Basics. (Bet you didn't even break a sweat.) You've witnessed the power of compounding and you understand how some common pitfalls can ruin even the healthiest investing plan. Now, let's turn to the various ways you can start investing.

Get started investing TODAY by join Motley Fool Stock Advisor! Every month, Motley Fool co-founders Tom and David Gardner offer members two stock recommendations every month, as well as daily market commentary on all of your favorite companies. Just click here to get started.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

I am a Stock Advisor subscriber and I understand that compounding interest delivers excellent growth. What I don't understand is how a stock actually compounds. One of your ads on the site mentions that since its IPO in 1970, Walmart has "turned every $10K into $57,000,000." How? By reinvesting the dividends back into the stock, stock splits, etc.? Or, does that mean that the initial $10K is worth $57,000,000 because the share price has risen so much? Or some combination?

Likewise, I don't really understand what it means that the Stock Advisor's recommendations have gained 42%. Does that mean someone would have to sell now to realize that 42% gain?

I'm not sure exactly how to ask but I know that I am not sure how someone actually makes money in the market besides buying low and selling high.

Thanks in advance your your response and any advice where I can read up on this.

What I know about investing I learned from Daddy Warbucks in the movie Annie. Smoke cigars and read the ticker tape machine while talking into at least three phones yelling "sell" and "buy"! I also have a certain amount of money, math skills, and irrational fear, so I figure I'll be a good investor. How do I start? I mean, how do I trade my money for stocks, and how do I convert stocks back into money?

I'm already participating in my company's 401K, but that was just a matter of picking some numbers and signing my name to a form. I make about $30 or $40 per year for the past 5 years from the 401k, which doesn't seem like enough to retire on. I think a 401K isn't a good thing, but maybe I'm not doing it right. Any help would be great.

"But what if we go all the way back to Wal-Mart's IPO, when it became a public company in October 1970? The business was valued at a tiny $21.5 million then. That means the stock is up more than 13,000 times since. That's more than 30% growth per year, and would have turned a $5,000 investment into $65 million today." - http://www.fool.com/investing/general/2004/12/17/be-a-penny-...

There is your answer. Yes, you would have to reinvest divs for this return. Use market caps for calculating return on investments because you don't have to factor in stock splits. The link below has a simple dividend reinvestment calculator however it fails to take into account irregular growth rates, but should give you a basic idea:

Fool newsletters measure performance by averaging the percentage gains in stock price of each recommendation arithmetically. What?! In plainer English, we simply add the percentage gains and divide by the number of recommendations. All stocks are weighted evenly, regardless of holding period. The S&P 500 returns, which we use for comparison in most cases, are calculated the same way. They represent the returns to an investor making regular investments in the S&P 500 on the same days our newsletters are released.

Our Motley Fool Income Investor and Motley Fool Inside Value newsletters include dividends in their return, accounted for by adjusting the cost bases of the respective stocks. These newsletters compare their returns to the SPDR unit investment trust, a dividend-incorporating exchange-traded fund that mimics the S&P 500.

Anyone who knows the system in the right aspects can make HUGE returns!

This is fact. Most are encouraged to do some reading on corporate law to give you a basic understanding of how our commerce works, this will help lead you to the better decisions to reap huge benefits. Don't forget use the same tools BIG business uses, take advantage of your corporate aspects as an individual.

And Remember!

One Dollar

Or as is said in latin backwords "ra ll od eno - II. I have recieved that the rationale of straw"

Build your haystacks utitilize the straw and trade for tangible objects "Gold, silver, etc. ..." (or as they do don't use the straw at all! that way you're not stuck to the legal aspects. checks, money orders, TIN, whichever you prefer.) The same tricks that have been getting used for years by the major corporations! notice the recession, cash for gold commercials skyrocketing, just one example! Providing massive return after stabilization and even if it doesn't you aren't stuck with paper if there is monetary failure ensuing a tradable substance. Remember it just takes a little insight and you'll be on your way to millionaire status in no time! Collect from the FatheringHay and establish your footprint!

Great post really like the numbers and the ideas for investing. Also really like the little jokes here and there. It's true that investing can seem like a scary idea and yes their are risks of loosing money instead of gaining money. The risk doesn't always have to be high though if you look at all the different investments you can do their is an investment for everyone. Also their are plenty of sits like this one, http://nafep.com, or Etrade that have professionals that are their to help you and answer your questions.

Good advice. Being a more cautious investor, I like diversification through Edward Jones Advisory Solutions for the long term. It doesn't make a killing, but so far it's steady and even if it declines significantly, I plan to stay with it.

If you invest, you will have a financial investment involved. That in of itself, will encourage you to discover more about the stock market and investing in general. Through that new found interest, your knowledge will grow and so will your investment. Initiative is the mother of experience.

The 5% CD rates and assuming you can average 10% a year on investments make this article sound more like a stockbroker sales pitch than an article from a website that supposed to be interested in leading beginning investors to the promise-land of real knowledge. In other words, it kind of shoots your credibility.

Completely agree with you in regards to 'knowing your goals'. You need to look at your financial future, not just the present. Through investments you will have more opportunities to be financially secured to pay for retirement, college graduation or special occasions. We talk about that on our radio show UnlockYourWealthRadio.com in our Keys to Riches: Dreams with Deadlines section. We need to set goals and reach these through strategic actions. Writing out each goal and measuring each step along the way will help us make realistic-aheiveable goals!

I am 13 years old and i have done some research online about stocks and how to pick them, I have my own google finance test portfolio. I have read books by Mr.Graham and Mr.Cramer. The latter said that if you were to buy a stock you should know the reason why your stock goes up or down. Needless to say i have no idea how to do that. Please help!!!!!